UNIT 2
FINANCING DECISIONS
FINANCIAL DECISONS
In any organisation funds are needed right from
promotion stage till the winding up of the
organisation.
If funds are inadequate the organisation suffers,
Hence it is necessary to estimate the correct
requirement of funds in the organisation.
Financial Decision help in assigning the exact
requirement of funds.
Capitalisation is one of the most important constituents of
financial plan.
The term “Capitalisation” has been derived from the word
capital and in common practice it refers to the total amount of
capital employed in a business.
‘Capitalisation’ is used in its quantitative sense and refers to
the process of determining the quantum of funds that a firm
needs to run its business.
According to Guthman and Dougall,
“Capitalisation is the sum of the par value of stocks and bonds
outstanding.”
MEANING OF CAPITAL STRUCTURE and
FINANCIAL STRUCTURE
Capital Structure: It refers to composition of its capitalization
and it includes all long term capital resources- Loans, reserves,
shares and bonds.
A financial Manager has to determine a proper capital structure
for the firm. ( Mix of debt and Equity)
Financial Structure: Refers to all the financial resources, short
as well as long term.
DETERMINANTS of CAPITAL
STRUCTURE
The capital structure decisions has to be planned in the
initial stages.
The management should aim at supplying requires
amount of capital.
The finance manager plays an important role by
studying and analysing the benefits and defects of each
security.
FACTORS INFLUENCING CAPITAL
STRUCTURE
Financial Leverage
Growth & stability of
Capital market
sales
Cost of capital conditions
Cash flow ability
Asset structure
Requirements of investors Purpose of finance
nature and size of firm Period of finance
Control Cost of floatation
Flexibility Personal considerations
Requirements of investors Corporate tax rates
Risk Legal requirements
CAPITALISATION
It refers to the total amount employed in a Business.
It includes – Share capital, Long term debt, Reserves
and surplus, short term debt and Creditors.
NEED FOR CAPITALISATION
At the time of Promotion
At the time of expansion
At the time of amalgamation
At the time of reorganising
Overcapitalization
What Is Overcapitalization?
Refers to the state of affairs where earnings of
company do not justify the amount
Overcapitalization occurs when a company has issued
more in debt and equity than its assets are worth.
An overcapitalized company might be paying more in
interest and dividend payments than it can sustain in the
long term.
Causes of Over
Capitalisation
1. Over Issue of Capital
2. Promotion, formation or development during Inflation
3. Buying assets of lower value at higher prices
4. High promotion expenses
5. Inadequate Depreciation
6. Liberal Dividend Policy
7. Taxation Policy
8. Inadequate demand
9. Payment of high Rate of Interest
10. Underestimation of the capitalisation rate.
Undercapitalization
It is the reverse phenomenon of over- capitalisation and occurs when a
company's actual capitalisation is lower than its proper capitalisation
as warranted by its earning capacity.
Undercapitalization occurs when a company has neither sufficient
cash flow nor the access to credit that it needs to finance its
operations.
The company may not be able to issue stock on the public markets
because the company does not meet the requirements, or the filing
expenses are too high.
The company cannot raise capital to fund itself, its daily operations, or
any expansion projects.
Causes of Under
Capitalisation
1. Under estimation of Capital requirements
2. Under estimation of future earnings
3. Promotion during depression
4. Conservative dividend policy
5. Very efficient management
6. Desire of control and trading on equity.
CAPITAL GEARING
It refers to the relationship between equity
capital and long term debt.
It means the ratio between the various types
of securities in the capital structure of the
company.
A company is said to be in a high gear ,
when it has a proportionately higher issue of
debentures and preference shares for raising
the long term resources.
OPTIMUM CAPITAL
STRUCTURE
The optimal capital structure of a firm is the best mix of
debt and equity financing that maximizes a company’s
market value while minimizing its cost of capital.
Minimizing the weighted average cost of capital (WACC)
is one way to optimize for the lowest cost mix of financing.
According to some economists, in the absence of taxes,
bankruptcy costs, agency costs, and asymmetric
information, in an efficient market, the value of a firm is
unaffected by its capital structure.
